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By 1996, I had accumulated some capital from consulting and
started to invest in other startups. Of the six startups I
invested in, three went out of business.

I learned a lot from the ones that failed. In 2000, I made my
biggest investment by far in a startup founded by two Harvard
dropouts -- one from its computer science department and the
other from its business school.

The pair was smart and each had great work experience at two
then-highly-respected companies -- Morgan Stanley and Netscape
Communications. The idea was to develop software that would help
companies manage business partnerships online.

Unfortunately, they could never figure out why the company
existed and they lacked a passion for a specific market or
technology. They never built a product and ran out of cash.

This failure cost me a six figure investment. Fortunately, my
venture capital investing benefited from very lucky timing,
riding the best part of the dot-com wave. The three other
companies in which I had invested were acquired for a total $2
billion -- more than offsetting my losses from the failures.

Nevertheless, that venture's failure stuck with me and it offers
four lessons that could help others looking to invest in startups
themselves:

1. Understand the business model.
I should have probed more deeply into exactly who would buy the
product, how much they would pay, whether the venture would sell
software or a service, if there were competitors -- and if so,
how fast they were growing. I never really understood the
venture's business model.

Asking these questions, I would have realized quickly that the
founders did not really know the answers or they might have said
that what they were doing was so new, there was no established
market.

2. Evaluate whether the venture meets an unmet
need.
I now know that one of the most common, but important, elements
left out of business plans is detailed customer research.
Customer interviews are important because customers are generally
reluctant to do business with a startup. The reason is simple:
most startups fail. There is little incentive for customers to
change their habits or business processes in order to work with a
startup that might disappear eight months later.

But most entrepreneurs, like the ones whose faulty venture I'd
invested in, do not reflect this in their business plans. They
present market-size and growth statistics that are generally
based on assumptions from research analysts that they don't
understand.

3. Know why the founders care about the
venture.
Startups generally lack the capital needed to pay above-market
salaries that draw in talent. If they are going to build great
teams, they must offer potential employees an exciting work
environment that flows from the founder's passion for the
business.

In my case, the CEO of this failed startup did not care deeply
about the problem his company was out to solve. As a result, the
venture flailed without direction and could not raise additional
capital after the dot-com bubble burst.

4. Invest with your mind, not your heart.
What is clear to me now is that I invested without thinking
clearly. I was swept up in my belief in the founders and the then
high odds of success for dot-com startups.

The bigger lesson from my failed investment is that during boom
periods, it is very difficult to resist the strong emotional pull
of the general economic environment. But it is precisely during
those times that applying a disciplined approach to investing is
most important.

Ironically, my investment mistake took place at the same time
that I was writing e-Stocks: Finding the Hidden Blue Chips
Among the Internet Impostors (HarperBusiness, 2001).